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This Just In: Upgrades and Downgrades

Google a boondoggle?

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our tool for rating stocks and analysts alike. With CAPS, we'll be tracking the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.

And speaking of the best ...Google(NASDAQ:GOOG) shares joined the rout on Wall Street yesterday, spurred by a downgrade to "source of funds" from a virtual Wall Street unknown. (For those unsure of the meaning, "source of funds" is a newish euphemism on the Street, translating roughly as "sell this garbage and put your cash to better use elsewhere.")

The analyst downgrading Google, San Francisco-based and London-owned ThinkEquity, observes that with Google now up 27% over the past three weeks, the shares are "currently reflecting a [second half of] 2009 recovery that we believe is unlikely to materialize."

According to ThinkEquity (TE): "the fundamental outlook for online advertising... continues to worsen." TE believes we're currently just four quarters into a "12-quarter media recession" that could hinder revenue growth at Google. The analyst predicts we'll see less than 4% year-over-year growth this year -- or less than half what the rest of Wall Street expects. (If it's correct, media conglomerates like Time Warner(NYSE:TWX) or News Corp.(NASDAQ:NWS) could be in for a rough ride as well.) But is TE correct?

Let's go to the tapeThe analyst doesn't have the longest record on CAPS, but what we've seen so far suggests that yes, ThinkEquity has a good mind for online media. Alongside such out-of-sector stocks as SunPower(NASDAQ:SPWRA) and InterMune(NASDAQ:ITMN), the analyst has buy ratings on Yahoo! (Google's nemesis) and Blue Nile (not media, but a fair proxy for the Internet business world):

TE says:

CAPS says:

TE's Pick Beating (Lagging) S&P by:

Yahoo!(NASDAQ:YHOO)

Outperform

**

8 points

Blue Nile (NASDAQ:NILE)

Outperform

**

14 points

SunPower

Outperform

***

18 points

Intermune

Outperform

*

59 points

And overall (and reiterating the caveat about the analyst's relatively short track record) ThinkEquity looks to be one of the better analysts on Wall Street so far. Most of the recommendations it makes, it makes right, and on average, the analyst is outperforming the S&P 500 by better than 7 percentage points per pick. That's good enough to rank ThinkEquity in the top quintile of investors tracked by CAPS.

Crunching the numbersPersonally, I'm not ready to run out and short Google just on ThinkEquity's say-so. Why not? Couple of reasons:

First, TE didn't quite tell us to sell Google at all. According to the analyst, when it labels a stock "source of funds," that only equals the "neutral" rating more often used in everyday Wall Street-speak. (Although for the life of me, I still can't figure how you can get "funds" out of a stock without selling it, any more than you can "accumulate" a stock -- TE's previous rating on Google -- without paying for it.) Regardless, the fact remains that TE says it doesn't really want you to sell Google -- just not buy it.

Second: After crunching the numbers, I tend to agree. Google generated $5.5 billion in free cash flow last year, which was considerably better than the $4.2 billion in net income it reported under GAAP. As such, the stock currently carries an enterprise value-to-free cash flow ratio of 17 -- which looks reasonable in light of analysts' predicted 20% long-term growth rate. Much more reasonable than the stock's 26 P/E might lead you to believe, in any case.

Foolish takeawayNow, if ThinkEquity is right about those growth expectations being over-optimistic, well, that would make the stock a bit less of a buy candidate, in my view. But a sell? Nope. Sorry, bears. We're not there yet.

Fool contributorRich Smithdoes not own shares of any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 728 out of more than 125,000 members. The Fool has a disclosure policy.

Author

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.